What is causing this kind of panic? Is it pure technical adjustment in the market?
It has got several factors – both local and global – playing together. On one hand, we have this concern about the rate hikes by the Fed and the concerns about inflation which obviously has ignited the worry that the rate hikes and quantitative tightening would possibly come over at a faster pace than we had earlier anticipated.
Second, we are also seeing the possibility of local contagion and the concerns about overvaluation in India compared to the peers. These are the two or three things that have combined together to lead to this correction. I would also point out that this is not an India specific issue. Across Asia, we have seen this and MSCI Asia ex-Japan itself has corrected about 2-3%. Of late, however, India has underperformed.
Are we nearing the end of this decline?
These calls are very difficult to take. In times like these, when you have a very sharp correction, those sectors and stocks which were overvalued which did not have valuation support very often, sees a degree of overshooting and undershooting. We had possibly seen the overshooting phase earlier in late 2021. We might see a degree of undershooting below the justifiable valuations now.
Having said that, I would like to argue that longer term investors, who like to focus on earnings estimates, things are not really looking that bad. Consensus earnings estimates have actually increased for some of the sectors that are heavily represented in the Indian market. Earnings estimates have increased for financials, IT services, consumer discretionaries and even some of the auto companies which are still facing the brunt of the supply chain disruptions.
Analysts and investors are beginning to take the call that the economic cycle is possibly just about starting. It is difficult to predict how long this short term correction would last but for longer term investors, sectors and stocks within the market are beginning to look attractive.
As we figure out the stocks which may be overvalued and still have a long road towards profitability, how is one supposed to make sense of this kind of a selloff when the markets even stop reacting to earnings from a Reliance Industries or ICICI or Axis Bank?
We have seen this playbook before. When there is a big global concern, some kind of a sword hanging over your head – which is essentially the liquidity retraction by the Fed which is almost certain – this kind of a market reaction takes place and will continue to take place in future.
There is no getting away from this. Having said this, I must also point out that there are some silver linings. We have seen the Asian currencies, particularly those in China, Southeast Asia and India remaining relatively stable and unhurt by this expectation of a very sharp retraction of liquidity by the Fed, it is clearly a positive and it is a bit of a departure from the previous rate hike and liquidity retraction episodes that we have seen from the Fed.
Earnings estimates going up is something I had earlier talked about. If one looks at some of the other variables like credit growth picking up – it is just beginning to happen. So, I do not think all is lost for the Indian equity market. In fact, we still have a constructive stance on Indian equities. We are overweight in our Asian model portfolio. We have a target of 62,000 by the end of 2022 for the Sensex but this volatility in the short term is something that we will have to grin and bear.
In particular, the tech stocks – the platform internet companies – which are overvalued to start with are technically called the long duration equities, where much of the present value of the company is in the terminal value. These are the ones that have suffered the most in anticipation of the cost of equity going up. These are the ones that do not have valuation support and unfortunately that is something we have to tolerate for now. There is no getting away from it.
You did have a Sensex target for 62,000 which at the start of the year looked like would be achieved very soon. But now there is a global sell off and that is why the fundamentals like earnings are not even at play at the moment. But this is a very different India from the great financial crisis. When we do see the unwinding will be far less, the equity markets will be more shielded than we have seen in the past?
We feel so about the entire Asian emerging market complex. There is a tendency to compare this episode to the taper tantrum episode in 2013 but we do not think the volatility would be as high as we had seen in that particular episode. We do not think the pressure on the Asian currencies, which are possibly the biggest drivers of equities in times like these, would be as depressive as we had seen in 2013.
There are a couple of reasons behind that. Number one is the country’s balance sheets in terms of their current account deficits and forex reserves. These economies are way more healthy than we had seen about eight years ago. Second, when one looks at the balance sheets of the corporates which are participating, the average debt to equity ratio is far lower than we had seen at that point of time. At the same time, even this particular round of Fed tightening had actually been well telegraphed. It had been talked about, it had been discussed incessantly by various different market participants and the governors of the Fed unlike the episode in 2013 which came as a surprise to the market. So yes, we have to live with short-term volatility but we do not really expect the kind of currency turmoil that we had seen in the previous episodes.
What explains the excruciating tech selloff? The Nasdaq, excluding yesterday’s rebound, is down 12% on a year to date basis as well. Even back home – Zomato, Paytm, Nykaa – have hit fresh lows for themselves. Some like Paytm and CarTrade are quoting at 50% below their issue price. What explains this synchronised tech selloff?
Synchronised is the word that you very rightly used. This synchronised selloff in a sense explains that the reason behind this selloff is also possibly the same across different markets. Whenever we have the likelihood of interest rates and cost of equity rising across all markets, the valuations which are essentially the discounted present value of the cash flows are going to accrue from these companies, these valuations tend to decline.
For tech companies, the majority of their valuation is in the terminal value because in the short term, they are not likely to generate any kind of cash. These valuations where the majority of the values and the terminal value tend to suffer more when there is a risk of cost of equity increasing. This is the universal truth. It is simple arithmetic that we have to live with. It is no surprise that when there is a possibility and an expectation of a very sharp rise in cost of equity, it is these companies which lack near term valuation support, that tend to suffer more. This is something that we are seeing across the world today.
Where are these pools of funds going to move to? Clearly a risk-off sentiment is on. It is not just equities but other fancied asset classes like Bitcoins are also seeing a big selloff. What has been holding out is only crude and gold. Where is the money going to move then?
The money could move into different pockets within equities. Some of the so-called value indices like the Russell 2000 have actually outperformed the growth charts like the tech indices quite handsomely over the last one to one-and-a-half months. In times like these, when valuation or lack of valuation support becomes a concern, investors tend to look at those companies that have valuation support and at the same time, in emerging markets like India, have a growth story attached to them.
So if we are able to find that sweet spot, then we could actually identify a few pockets.
In fact, in India, there are quite a few pockets where money could still move into. We are actually seeing that not so much from the foreign investors side, but possibly from the domestic investors’ side. There is a degree of support and neutralisation of the FII outflow by the domestic investors. We are living in a world of two very heightened, increased degree of volatility but once we are past this, investors would begin to look at those sectors which offer valuation support and at the same time a degree of a growth story being attached to them going forward.
What is in store for 2022? Is it about protecting gains or is it about buying risk? Is this panic an indication that cycles are reversing or is this a panic or a selloff which we will look back six months or a year from now and call it one of the best buying moments of 2022?
2022 as a whole for emerging markets would possibly be a flattish year. Within emerging markets, we expect Asia to outperform. We think Asian corporate balance sheets, Asian stability or earnings estimates are better than other emerging market pockets like Latin America. Within Asian emerging markets, India and a few other markets like China or Korea would outperform and therefore we have overweight stances on these markets.
Having said this, I must also point out that the Indian market would not have as strong a year as 2021 or 2020. We have seen possibly three years of very strong returns from Indian equities as a whole. So the fourth year in succession would possibly not be as strong. I would expect returns from the Asian markets in the range of about 7-8% and possibly a little higher from the Indian market which is actually encapsulated in the kind of Sensex target we have at 62,000.
It is about 56,000 now on the Sensex which is about 10-11% up from here. Hindsight is always 2020. So we a couple of months down the line, possibly we might think that this downturn was the best time to buy. For long-term investors and someone who is consistently investing in the equity market, trying to time the equity market is really difficult.
So for longer term investors, it is important to look at quality stocks which have the degree of valuation support and a certain degree of growth story over the next few years and possibly stagger their buying momentum, stagger the quantum of money that they want to invest over a certain period of time. There are sectors available, banks are one of them, IT services are one of them. I highlighted these two as having increased their earnings estimates. We are also positive on select consumer discretionaries in the auto universe. Conglomerates in energy, possibly in the TMT sector, also fit the bill.